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McMillan Shakespeare (ASX:MMS) Hasn't Managed To Accelerate Its Returns

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at McMillan Shakespeare (ASX:MMS), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for McMillan Shakespeare:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.20 = AU$126m ÷ (AU$1.2b - AU$575m) (Based on the trailing twelve months to December 2023).

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Therefore, McMillan Shakespeare has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 15%.

View our latest analysis for McMillan Shakespeare

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In the above chart we have measured McMillan Shakespeare's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for McMillan Shakespeare .

The Trend Of ROCE

There hasn't been much to report for McMillan Shakespeare's returns and its level of capital employed because both metrics have been steady for the past five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So it may not be a multi-bagger in the making, but given the decent 20% return on capital, it'd be difficult to find fault with the business's current operations. That being the case, it makes sense that McMillan Shakespeare has been paying out 90% of its earnings to its shareholders. These mature businesses typically have reliable earnings and not many places to reinvest them, so the next best option is to put the earnings into shareholders pockets.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 48% of total assets, this reported ROCE would probably be less than20% because total capital employed would be higher.The 20% ROCE could be even lower if current liabilities weren't 48% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

The Bottom Line

In summary, McMillan Shakespeare isn't compounding its earnings but is generating decent returns on the same amount of capital employed. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 132% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing to note, we've identified 3 warning signs with McMillan Shakespeare and understanding them should be part of your investment process.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.